BOK Financial - Q3 2023

Transcript

Operator (participant)

Greetings, and welcome to BOK Financial Corporation Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Marty Grunst, Chief Financial Officer for BOK Financial Corporation. Thank you, Mr. Grunst. You may begin.

Marty Grunst (CFO)

Good morning, and thank you for joining us. Today, our CEO, Stacy Kymes, will provide opening comments. Marc Maun, Executive Vice President for Regional Banking, will cover our loan portfolio and related credit metrics, and Scott Grauer, Executive Vice President of Wealth Management, will cover our fee-based results. I will then discuss financial performance for the quarter and our forward guidance. PDFs of the slide presentation and third quarter press release are available on our website at bokf.com. We refer you to the disclaimers on slide two regarding any forward-looking statements we make during the call. I will now turn the call over to Stacy Kymes.

Stacy Kymes (CEO)

Good morning, and thanks for joining us to discuss BOK Financial's Third Quarter Financial Results. Starting on slide 4, third quarter net income was $134 million, or $2.04 per diluted share. Our team had another solid quarter of earnings, driven by our diverse business model, which prudently balances interest revenues with non-interest revenues and allows us to perform well in a variety of business climates. Fee and commission revenues were 40% of total revenue for the quarter. This quarter, our public and corporate finance group established a new record for investment banking fees, which materially offset last quarter's record-high derivative fees. Additionally, we continue to focus on opportunities for growth given the economic vitality of our core geographic footprint as we take advantage of our capital and liquidity strengths.

Total loans have increased almost 9% from last year, and our core commercial and industrial loans were up 8%. We are poised to introduce our full-service banking model into the San Antonio market. With the addition of a fixed income sales and trading office in Memphis, we are confident both will drive long-term shareholder value. Turning to slide five, period-end loan balances increased $486 million, or 2.1% linked-quarter, with growth in both C&I and commercial real estate. Both period-end and average deposits continued to grow during the quarter. Our loan-to-deposit ratio increased just slightly to 70.5% at the end of the quarter as loan growth outpaced deposit growth. Our cost for deposits did increase linked-quarter. However, the pace did slow.

As Marty will detail later, our reported net interest margin continues to be diluted by the expanding trading activity this quarter, with our core margin excluding the trading activity at 3.14%. Although it will take a few quarters to become clear, we are seeing early signs of loan spreads increasing in our footprint as credit tightens and deposit costs remain high. The pressure on our net interest margin from increased funding costs resulted in a $21 million linked quarter decline in net interest revenue, resulting in an efficiency ratio above 60%, which is more typical for us given the mix of non-interest revenue. Credit quality is still strong, and we have a combined reserve of $325 million, or 1.37% of outstanding loans at quarter end, which is notably above the median of our peer group.

Finally, we repurchased 700,500 shares this quarter to reflect our long-term confidence in the company and attractive repurchase valuations. I'll provide additional perspective on the results before starting the Q&A session, but now Marc Maun will review the loan portfolio and our credit metrics in more detail. I'll turn the call over to him.

Marc Maun (EVP of Regional Banking)

Thanks, Stacy. Turning to slide 7, period-end loans were $23.7 billion, up 2.1% linked quarter. Total C&I loans increased $185 million, or 1.3% linked quarter, with year-over-year growth of $1.1 billion, or 8%. Commercial real estate loans increased $270 million, or 5.4% linked quarter, and have increased $767 million, or 17% year-over-year. Compared to December 31, 2020, CRE balances have grown at a modest 3.8% annualized growth, with commitments up 5.8% during that same period. Growth this quarter was primarily driven by multifamily properties, with an increase of $232 million, or 13.4% linked quarter.

Industrial facility loans grew $83 million, or 6.1% linked-quarter, which was offset by a $24 million or 2.4% linked-quarter decline in loans secured by office facilities. The $982 million in outstanding office loans is at its lowest point since June 2020 and is only 4% of total outstanding loan balances. The year-over-year CRE growth of $767 million was predominantly driven by multifamily and industrial loans. We have an internal limit of 185% of Tier 1 Capital and reserves to total CRE commitments and are presently at the upper end of that limit. We do expect continued modest growth in outstanding CRE balances as construction loans fund up. As of September thirtieth, CRE balances represented 22% of total outstanding loan balances, a ratio well below our peers.

Combined services and general business loans, our core C&I loans increased $112 million, or 1.6% linked-quarter, with year-over-year growth of $716 million or 11%. These combined categories are 30% of our total loan portfolio. Healthcare balances increased $92 million, or 2.3% linked-quarter, and have grown $257 million or 6.7% year-over-year, primarily driven by our senior housing sector. Healthcare sector loans represented 17% of total loans at quarter-end. Energy balances decreased $18 million linked-quarter and have increased $119 million or 3.5% year-over-year, with period-end balances at 15% of total period-end loans. Year-over-year, loans have grown $1.9 billion or 8.9%.

Excluding PPP loans, Q3 2023 extends the linked-quarter loan growth to eight consecutive quarters. Our current pipeline is strong and we're confident we have momentum to drive additional growth in the loan portfolio well into next year. Turning to slide 8, you can see that credit quality continues to be exceptionally good across the loan portfolio and well below historical norms and pre-pandemic levels. Non-performing assets, excluding those guaranteed by U.S. government agencies, decreased $12 million this quarter. Non-accruing loans decreased $13 million linked-quarter, primarily driven by a decrease in commercial real estate loans. The provisions of credit losses of $7 million in the third quarter reflect strong asset quality, continued loan growth, and modest changes in our economic forecast. We remain in a solid credit position today.

With a ratio of capital allocated to commercial real estate that is substantially less than our peers and a history of outperformance during past credit cycles, we believe we are well positioned should an economic slowdown materialize in the quarters ahead. The markets continue to be focused on the office segment of real estate, given the trends in workforce preferences, although the verdict is still out as to whether that will be sustained, as the pendulum seems to be shifting back to more time in the physical office. Our office segment maturities are generally ratable over the next three to four years, and we have a mini-perm option if the markets are not conducive to long-term permanent financing.

The average loan-to-value ratio in the office space is below 65%, and average cash flow coverage exceeds 1.3 times based on our most recent review at the end of 2022. Net charge-offs were $6.5 million, or 11 basis points annualized for the third quarter, and have averaged 13 basis points over the last twelve months, far below our historic loss range of 30-40 basis points. Looking forward, we expect net charge-offs to remain low. The combined allowance for credit losses was $325 million, or 1.37% of outstanding loans at quarter end. The total combined allowance is available for losses, and any apples-to-apples industry comparison should include the combined reserves. We expect this ratio to remain stable as loan growth continues and economic conditions persist. I'll turn the call over to Scott.

Scott Grauer (EVP of Wealth Management)

Thanks, Marc. Turning to slide 10. Total fees and commissions were $198 million for the third quarter, down slightly linked quarter. Our wealth segment continues to set new quarterly highs for fees and commissions at $123.6 million this quarter, eclipsing the previous high set last quarter. Fees and commissions for the second quarter included record results for energy customer hedging as well as annual tax service fees. Although energy hedging customer and tax service fees were down linked quarter, these were partially offset by record results this quarter in our public and corporate finance groups, driving a $5.3 million increase in other investment banking fees.

The $2.5 million linked quarter decline in trading fees was primarily related to fees from our municipal bond trading portfolio, down $3.5 million linked quarter, which was influenced by rising interest rate environment and evolving market expectations during the third quarter. This was partially offset by a $1.1 million increase in our MBS trading activities. Fiduciary and asset management fees were $52 million for the third quarter, a 1.4% linked quarter decrease due to the second quarter's annual tax service fees. Our assets under management or administration were $99 billion at quarter end. Our asset mix for assets under management or administration moved slightly this quarter, with 43% fixed income, 32% equities, 16% cash, and 9% alternatives.

We are proud of our diversified mix of fee income, which we believe is a strategic differentiator for us when compared to our peers, especially during times of economic uncertainty. We consistently rank in the top decile for fee income as a percentage of total net interest revenue and non-interest fee income. Our revenue mix averaged 37% during the last twelve months. That consistently supports a revenue stream that is sustainable through a wide variety of economic cycles. I'll now turn over the call to Marty.

Marty Grunst (CFO)

Thank you, Scott. Turning to slide 12. Third quarter net interest revenue was $301 million, a $21 million decrease linked quarter. Net interest margin was 2.69%, a 31 basis point decrease versus Q2. I will note that 8 basis points of the 31 basis point margin decline was due to growth in the trading securities. As the trading securities grow, it dilutes the net interest margin as it grows earning assets at a narrower spread compared to the rest of the balance sheet. Net of the 8 basis point impact from trading, the remaining 23 basis point decline was driven by the competitive deposit environment, as average interest-bearing deposit costs increased by 61 basis points linked quarter. Our cumulative interest-bearing deposit beta increased to 58% for the third quarter, and non-interest DDA continued to shift into interest bearing.

DDA as a percent of total deposits was 29.6% as of September 30. This slide shows net interest margin and net interest revenue with and without the impact of the trading business to better highlight trends and comparability. For the third quarter of 2023, the net interest margin, excluding the impact of trading assets, was 3.14% versus 3.36% in the second quarter. Growth in earning assets during the quarter was driven by trading securities and loans, partially offset by a decline in our fair value option securities used to hedge our mortgage servicing assets. Turning to slide 13, liquidity and capital continue to be very strong on an absolute basis and versus peers.

Total deposits grew $358 million on a period-end basis, and the loan-to-deposit ratio was 70.5%, up slightly from the previous quarter. Average total deposits increased $918 million linked-quarter, with average interest-bearing deposits up $1.8 billion, partially offset by an $840 million decline in demand deposits. Brokered CDs have recently been a topic for our industry, and we note that our usage of that funding source over time is generally low, but not zero. Brokered CDs were $688 million, or less than 2% of total funding at quarter end and declined $72 million versus the prior quarter end.

Our tangible common equity ratio is 7.74%, down 5 basis points linked quarter due to balance sheet growth and increases in interest rates, but up 11 basis points from year-end 2022. Adjusted TCE, including the impact of unrealized losses on held to maturity securities, is 7.35%, consistent with year-end 2022. CET1 is 12.1%, and if adjusted for AOCI, would be 9.7%. As the recent regulatory capital proposal is largely focused on banks over $100 billion, we have ample capital to support continued organic growth, while at the same time allowing for continued share buyback. During the third quarter, we repurchased 700,500 shares at an average price of $84.17 per share.

Turning to slide 14, linked-quarter total expenses increased by $5.6 million, or 1.8%. Personnel expense was flat linked-quarter as increases related to our San Antonio and Memphis expansions were mostly offset by a decrease in employee benefits. Non-personnel operating expense grew $5.5 million. Occupancy and equipment increased $2.5 million, driven by the retirement of certain ATMs as we upgrade our network. FDIC insurance expense increased $1 million. Combined, all other expense categories increased $3.3 million, much of that related to an accrual for certain disputed matters. Year-over-year, total operating expense increased $30 million or 10%. Personnel expense increased $20 million or 12%.

However, $3 million of the year-over-year increase was related to a one-time benefit during the second quarter of 2022 from the dissolution of our pension plan, combined with linked-quarter market adjustments for deferred compensation. Third quarter 2023 also includes $2.6 million of expansion-related personnel costs. Cash-based compensation related to new business production increased $6.8 million. The remaining $8 million year-over-year increase was primarily regular salaries and benefits, with that directly related to annual merit increases and a much lower level of open positions. Year-over-year, other operating expense increased $9 million or 7.3%. Occupancy and equipment increased $3.3 million, with $2.5 million related to the ATM retirements.

FDIC insurance increased $3.7 million, as both the assessment base and the rate increased, and data processing increased $3.9 million, primarily due to continued investments in technology. These were partially offset by a $1.1 million decrease in mortgage banking costs as MSR amortization slowed. Turning to slide 15, I will note that we are in the middle of our 2024 financial planning process, so we are not ready to provide forward-looking assumptions with the same level of detail as we have for the last few quarters. However, I will provide the following higher level expectations for the next 15 months. We continue to expect upper single-digit annualized loan growth. Economic conditions in our geographic footprint remain favorable and continue to be supported by business in migration from other markets. The competitive environment for loans should be a tailwind for us.

We expect to continue holding our available-for-sale securities portfolio flat and to maintain a neutral interest rate risk position. We expect total deposits to be stable or grow modestly and the loan-to-deposit ratio to remain in the low 70s. Currently, we are assuming no additional rate changes by the Federal Reserve in 2023 or 2024. We believe the margin will migrate modestly lower over the next couple quarters as interest-bearing deposit betas level out and demand deposit balance attrition runs its course. In aggregate, we expect total fees and commissions revenue to grow at a mid-single-digit growth rate on a year-over-year basis and our strategic expansion initiatives to positively impact growth rates for 2024. We expect expenses to increase modestly as we continue to invest in strategic growth and technology initiatives, with revenue growth following at a slight lag.

We expect the efficiency ratio to increase with net interest margin changes, then migrate downward as revenue growth is realized.

This does not include the impact of the FDIC special assessment, which could be finalized in the fourth quarter of 2023. Our combined allowance level is above the median of our peers, and we expect to maintain a strong credit reserve. Given our expectations for loan growth and the strength of our credit quality, we expect quarterly provision expense near recent levels to continue and an eventual move towards normal credit costs later in 2024. Changes in the economic outlook will affect our provision expense. Additionally, we expect to continue our opportunistic share repurchase activity. I'll now turn the call back over to Stacy Kymes for closing commentary.

Stacy Kymes (CEO)

Thanks, Marty. This quarter highlights the benefits of our diverse revenue mix and our strong risk management culture as we and the industry experience pressure on the margin from increased funding costs. While margin pressure is a reality for us and our peers, our diverse fee-based businesses supply a strong core revenue base that sets us apart. Excluding the volatile mortgage refinance fees during the second and third quarters of 2020, the last five consecutive quarters are the highest for fee income in the company's history. We continue to grow and invest in our fee businesses, as shown by our recent expansion into Memphis, and our talented teams collaborate well to ensure we grow our company the right way, a way that is sustainable through all economic cycles.

While the market continues to focus on capital, liquidity, and credit, I see this as a unique opportunity to use our strength in these areas to grow organically and invest in new markets, while other financial institutions may be more internally focused. We are focused on using the strength of our geographic footprint to grow, both in today's climate and in the years ahead. With that, we are pleased to take your questions. Operator?

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. The first question comes from the line of Brady Gailey with KBW. Please go ahead.

Brady Gailey (Managing Director)

Yeah, it's Brady. Good morning, guys.

Marty Grunst (CFO)

Good morning.

Stacy Kymes (CEO)

Good morning, Brady.

Brady Gailey (Managing Director)

But I was just wondering, you know, your guidance for some continued net interest margin pressure. We saw a big move in the third quarter. How do you think about the magnitude of how much the margin could decline over the next quarter or two?

Marty Grunst (CFO)

Yeah, good question, Brady. So, you know, I think the way to think about the next quarter or two, maybe give you a little context. So number one, I kind of set aside the trading impacts. You know, there's really no reason to think that that would be any different. It'll react to the markets, and even if it's different, that's really denominator effects and don't really drive the numerator so much. So Q3 margin decline ex trading was 23 basis points, and so the positive drivers there were, you know, the bond portfolio repricing up, the fixed rate portions of the loan book repricing up, and loan growth. The negatives were the DDA mix shift and the deposit beta piece. So Q4 should basically see the same positives at very similar magnitudes, but the negatives in aggregate will be smaller.

So we expect to see a smaller decline than that 23 basis points in the core margin, Q3 to Q4, but still probably in the low double digits of basis points. And, you know, it's really the beta slowing down that's going to be the, the component that helps there. Going into Q1, you know, we still think that the, you know, positives are about the same in magnitude, but the negatives will still outweigh those positives to a lesser degree, and we'll see another, but probably smaller margin decline. And then after that, it's, it's increasingly likely that the balances, the positives balance out or outweigh the negatives. But we'll give you some more color on that in January.

Brady Gailey (Managing Director)

Okay. And then, you know, loan growth at a high single-digit pace, you know, is pretty robust today. I mean, relative to your peers, there's not many banks growing at that level. So what-- you know, how, how are you able to, you know, kind of grow at that elevated pace relative to your peers in the industry today?

Marc Maun (EVP of Regional Banking)

Yeah, Brady, this is Marc Maun. Fundamentally, you know, our balance sheet is well positioned to allow us to grow with a liquidity, a loan-to-deposit ratio of 70%. We have the liquidity capacity to grow. Our credit metrics are as good as they've ever been. I mean, with criticized levels at half where they were pre-pandemic, and we don't see any significant issues on the horizon. So we've been able to focus on our sales efforts and getting out and getting our teams out in the field, working with companies to generate loan growth. And while some of our peers are pulling back in that space, that has allowed us to grow not just in one particular area, but pretty broadly across our C&I portfolio, healthcare, and energy.

Real estate, you know, we are expecting some modest growth just because of our own internal limits, but we don't, we have no reason to discontinue that effort, and we're going to be very focused on that in this quarter and in 2024.

Stacy Kymes (CEO)

Brady, this is Stacy. I just might add, I think that, Marc really hit on, and it's been a real focal point for us as we've seen the disruption in the industry, is others are having to manage the liquidity and capital constraints. We're not.

This is a really unique opportunity we have, that maybe you get once every 15 years or so, to definitely take market share and grow, when others are less able to do that. And so that's been a real significant focus for us. And what I like about the growth is how it's been core C&I growth. You know, we really, over the last year, energy is such an important part of our business, but energy hasn't driven that. Historically, a lot of times when we have strong C&I growth, energy is the big driver. We've had huge growth in commitments there, but the outstanding's have not. And so if you think about by market, it's really been across our footprint.

Each of the markets has really had a strong year in terms of growth in C&I, particularly, and, it's been a focus for us. And so I think that, you know, we're optimistic that we can maintain that.

Brady Gailey (Managing Director)

Okay. All right, and then, finally, for me, is just on the fee income side. It's been such a great story for BOK this year, growing fee income. Is there any pieces of your fee income that you think are, you know, over-earning right now, that could, that could normalize lower? Or is all this growth real? And, you know, mid-single-digit fee growth is great for this year. Like, is that, is that the way we should kind of think about fee income growth longer term for BOK, in this mid-single-digit level?

Marty Grunst (CFO)

Yeah, Brady, this is Marty. Yeah, we do think that, you know, that, that is good, solid franchise growth that we've been able to generate. And if you look out over, you know, any 12-month or so period, you know, we're able to grow that consistently at that mid-single-digit level, and we feel the same about that, today that we did a quarter ago.

Scott Grauer (EVP of Wealth Management)

You know, Brady, this is Scott. I would add that, you know, that if you look at the components, second quarter to third quarter, we had record highs in the second quarter in a couple of different lines. So our energy had we had different pieces that were at the top of the list in the second quarter. That's alternated in the third quarter, where we have investment banking and other areas. So it's not coming from any one particular segment or piece. So you've got diversification of those fee and commission revenue sources, just like we do at the top of the house, from a revenue perspective. So we feel good about the fact that the various business lines have the ability to generate fees and commissions, just all types of fee revenues, regardless of what cycle we're in.

Brady Gailey (Managing Director)

Okay, got it. Thanks, guys.

Operator (participant)

Thank you. Next question comes from the line of Peter Winter with D.A. Davidson. Please go ahead.

Peter Winter (Managing Director)

Hi, good morning. I was wondering, can you provide some guidance, Marty, how you're thinking about net interest income in the fourth quarter? Just there's so many moving parts, and how you're thinking about the trading portfolio and where you think net interest income would bottom. Do you think it's kind of the second quarter, we could get to the bottom?

Marty Grunst (CFO)

Yeah. So, Peter, let me just give you a little bit of, of color on the net interest revenue, kind of the components. So you know, loan growth, that'll give you something like. We, we had about $450 million of loan growth, and that's coming in at a 250 spread. That's one of your positives. Bond portfolio reprice, you know, that averages $450 million a quarter, and you kind of get a run-off rate around 270-275 basis points, and a reinvestment yield that's, you know, whatever current market rates were. But in the third quarter, we're able to do that at 550. Fixed rate loan reprice, you know, that's about another $350 million that's repricing up each quarter, 300 basis points. And so those are the, the positives.

Deposit betas were still a pretty large impact in Q3. You know, we saw a nice slowdown in the pace of increase in September, and so, you know, we ended the quarter with a 58% cumulative beta, and so we can see that slowing, and so that slowdown will benefit Q4 and forward. And then the DDA mix shift, we still see that as a higher number in Q4 with you know, likely slow down after that.

Stacy Kymes (CEO)

Peter, this is Stacy. I think the answer, to be specific, I think that you know, Marty has kind of provided the pieces there, but our view is that you'll have more margin deterioration in the fourth quarter, less in the first quarter. And our current view is that it's likely in the first quarter that both margin and net interest revenue are kind of where they trough, and then we begin to build back from there, plus or minus, with you know, not a high degree of precision around the absolute numbers. But certainly directionally, we think that we likely bottom somewhere around the first quarter.

Peter Winter (Managing Director)

Okay. Got it. Thank you. And then, Stacy, just expenses. If I think about the company and the strategy, and I understand with competitors pulling back, and you're taking advantage of this opportunity and investing, is there any thought of maybe slowing down some of these investment spending next year, just given somewhat of a challenging revenue environment?

Stacy Kymes (CEO)

No, I mean, if, if you think about it, I mean, Peter, you've followed us for most of my career here, it feels like. I mean, our, our view is we're running this company not for the next quarter or for the next year, but for the next 5 years or 10 years or 15 years. And so you, you get these opportunities like this, you have to take advantage of it. And I understand the optics, but, because of our mix of fee revenue, we're not a sub 60% efficiency ratio company. We've never been. And so having a, you know, low 60s efficiency ratio doesn't bother us at all, because we've got 40%-50% of our, our revenues from, from fee-based businesses that carry a higher efficiency ratio. And so we're going to be prudent about expenses.

We're not going to do anything, you know, that's imprudent there, but we're going to grow the company, and we're going to think about things from a long-term perspective, not a short-term perspective. That's maybe the most distinctive advantage we have as a financial institution, and we're going to take advantage of that.

Peter Winter (Managing Director)

Okay. And just my last question, just deposit betas. I guess the outlook was 64% by year-end. I'm just wondering if you could update that and how you're thinking about it next year.

Marty Grunst (CFO)

Yes, we are thinking about that still as 64%-65% for the end of this year, and then, you know, we do expect that to slow quite a bit next year.

Peter Winter (Managing Director)

Any idea where it kind of settles out at?

Marty Grunst (CFO)

Yeah, it's probably a little too early to tell, but, but quite a bit lower. I mean, we saw some nice slowdown in September, and, you know, we expect to see that slowdown continue.

Peter Winter (Managing Director)

Got it. Thank you.

Operator (participant)

Thank you. Next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please go ahead.

Jon Arfstrom (Managing Director)

Hey, thanks. Good morning.

Marty Grunst (CFO)

Good morning. Morning, Jon.

Jon Arfstrom (Managing Director)

Marc, maybe a question for you. In your prepared comments, you talked about some limits on commercial real estate concentrations, and I'm just curious what that means for overall commercial real estate growth, and I'm particularly interested in the multifamily and industrial, because they've been such big drivers of growth for you guys.

Marc Maun (EVP of Regional Banking)

Right. What I talked about was we do try to manage our exposure in real estate to a certain percentage of capital, and we're at the upper end of that range. So we have seen growth, a lot of the growth that we've seen this year has been funding up of existing deals and construction loans and the number of payoffs have slowed due to the situation in long-term markets. So we expect that we still have room for modest growth in that next year, but it's not going to be at the double-digit rate that we've seen year-over-year in CRE so far. We are focused on multifamily and industrial. That's where the growth has been. We don't see those markets slowing down too much.

We're not focused on retail and certainly not on the office piece. So we—you know, again, it'll be something modest. It won't be in the same kind of growth rate we had overall, this year.

Jon Arfstrom (Managing Director)

Okay. Okay. Also, on that same slide, talk about what you're doing in office. I know it's not huge exposure for you, but I do see it's down, and you talked. You made a comment about a mini-perm option.

Marc Maun (EVP of Regional Banking)

Right

Jon Arfstrom (Managing Director)

To solve some, you know, potential issues. Can you talk a little bit about that?

Marc Maun (EVP of Regional Banking)

Well, right, you know, currently, our office portfolio is very strong from a credit standpoint. If we reach a maturity with one of the office loans, they're all in good shape at this point in time, and we would have the ability to, you know, to extend that loan for a short period of time until longer-term markets may open up. But we really have no significant credit issues at all in the office portfolio at this time.

Stacy Kymes (CEO)

So Jon, for us, a mini-perm would be some kind of, you know, 20-year amortization on a 3-year term, 3-year maturity, you know, based on, you know, the borrower doesn't have to find a permanent refinancing source. We can give them a short maturity, but a longer am, consistent with the permanent markets, to bridge them until when the permanent markets are more healthy.

Jon Arfstrom (Managing Director)

Yep. Okay, makes sense. And then, you know, your, your stock's getting beat up a little bit this morning, and, and it's, you know, it's on the NII and margin guide, I think, primarily. But, you've been active in the buyback. I'm just curious, and, and you bought a lot higher, quite frankly. So I'm just curious your, your kind of buyback appetite and, and capacity, especially where the stock is. Thanks.

Stacy Kymes (CEO)

Yeah, I think you can assume that given where the stock is today and given where we bought it in the third quarter, we would have a very high appetite for repurchasing shares.

Jon Arfstrom (Managing Director)

And capacity in general?

Marty Grunst (CFO)

Yeah, we have very strong capital ratios, and we've got the capacity we need to do that.

Jon Arfstrom (Managing Director)

Okay. Okay, thank you.

Operator (participant)

Thank you. Next question comes from the line of Brandon King with Truist Securities. Please go ahead.

Brandon King (Equity Research Analyst)

Hey, good morning.

Stacy Kymes (CEO)

Morning, Brandon.

Brandon King (Equity Research Analyst)

Yeah, so I wanted to get more context around how you're thinking about the efficiency ratio trends over the next year or so, or maybe beyond a year. Just given, you know, your initiatives and, you know, how the interest income is trending and fee income, just when do you think that efficiency ratio finally peaks, and you finally see maybe some stability or maybe it's coming down?

Stacy Kymes (CEO)

Brandon, the efficiency ratio has never been a metric that we manage to, and so, you know, we're obviously in the middle of our budget preparations for next year, so we're not going to provide guidance around that today. But what I can tell you is every business that we have has a target kind of efficiency ratio that we think about. And so what changes our efficiency ratio over time, more than anything else, is the mix of fee businesses. When fee businesses are a higher percent of total revenue, the efficiency ratio comes up and when net interest revenue is a higher percentage, then the efficiency ratio will go down. But we'll continue to look at that by line of business, and manage each line of business inside of our kind of implied expectations for efficiency.

We'll continue to look for opportunities, as we go through this fall season, to look for opportunities for efficiency. But we don't run our company that way because so much of the mix of revenue guides that efficiency ratio. So that's not how we think about, nor how we run the company.

Brandon King (Equity Research Analyst)

Okay. And just to follow up on that, with these initiatives and your expectations for when that revenue growth will be realized, and I know there's a lot of moving parts around that, but could you just give us more context on how you're thinking about when and the timing of that, just based off of, you know, preliminary plans?

Marty Grunst (CFO)

Yeah, just to give you a couple examples, Brandon. So if you think about our Memphis expansion as one of those, you know, that's sales and trading producers, so that has a fairly rapid ramp-up, just given the nature of that business. Our San Antonio investment, you know, that's commercial and wealth, you know, primarily. And so, you know, those all have longer sales cycles, and so that'll take a little bit longer to ramp that up than, you know, when compared to the Memphis expansion. So, you know, it's kind of individual investment centric. So hopefully that helps.

Brandon King (Equity Research Analyst)

Okay. Okay. And then on the technology initiatives, could you just give us more color on kind of what you're planning on doing that you're currently not doing now, and how you expect that to ramp as you try to manage the company over the next, you know, five years?

Stacy Kymes (CEO)

So Brandon, over the last several years, we've made material investments in our treasury platform and our customer interface, into our commercial and corporate interface, into our existing technology systems. We have significant investments in our wealth platform that are underway, that we're continuing to work through. And so, as I mentioned previously, we're running the company for the long term, not the short term. And so we continue to make investments to ensure our technology platforms are competitive in providing our customers with a really positive experience when they interface with us.

Brandon King (Equity Research Analyst)

Okay. I will hop back in the queue. Thanks for taking my questions.

Operator (participant)

Thank you. Next question comes from the line of Matt Olney with Stephens Inc. Please go ahead.

Matt Olney (Managing Director)

Hey, thanks. Good morning. I wanna go back to loan growth, and I think it's good to hear you guys talk about the bank taking advantage of some competition pulling back some as they manage their capital liquidity. Any commentary about how much of the growth is from larger sized deals or syndications? I just want an appreciation of how much of the growth is larger deals, you know, existing syndications versus taking on new customers.

Marty Grunst (CFO)

Well, it's a combination of all that. Actually, we have not had any, you know, material increase, like in the third quarter, in the number of SNCs that we're involved with. Our leveraged loans are actually going down, so we're focused on businesses where we can develop a relationship that's broad-based. And so we're getting a mix of new customers, as well as finding our way into some club deals, et cetera. But nothing, we're not focused on just getting into syndicated deals and buying participation, where we don't have a significant opportunity for relationships.

It's core middle market, right down the middle of the fairway, as we consistently are over time.

Yeah, the—the—you know, the, as Marc mentioned, the SNC number of SNCs isn't different for us between second quarter and third quarter. You know, to the extent that we're in the shared national credit, there is a direct relationship with the borrower. We typically have other business associated with them. I think the growth that we're seeing is really, and why I'm excited about it, is because it is core, it is direct relationships, people that we've been calling on, opportunities are being created. And so that's really important to us, and it's franchise building over the long term.

Matt Olney (Managing Director)

Okay. That's helpful, guys. My other questions have been addressed. Thank you.

Stacy Kymes (CEO)

Thank you.

Operator (participant)

Thank you. A reminder to all the participants that you may press star and one to ask a question. Next question comes from the line of Timur Braziler with Wells Fargo Securities. Please go ahead.

Timur Braziler (VP)

Hi, good morning. Following up on that last line of commentary, do you have the total balance of, of Shared National Credits and participations in the quarter?

Marc Maun (EVP of Regional Banking)

Yeah. The Shared National Credit volumes are about 24% of our total portfolio. And that's kind of mostly in the energy and C&I space, those two areas make up about 80% of the total Shared National Credits. We do agent about 25% of those, and about 80% of them are in our local markets. So we're not going outside of our footprint in tracking down those kinds of loans.

Timur Braziler (VP)

Okay. Switching to the deposit base, the decline linked quarter and demand deposits still is pretty elevated. Demand is now less than 30% of the total base and is below pandemic levels. I guess, what are you seeing from a liquidity standpoint from your borrowers? I know you said that that pressure seems to be abating. I guess, what's the outlook for demand deposits, as we go into the fourth quarter and into 2024?

Marty Grunst (CFO)

Yeah. So, so we saw, you know, DDA average balances down $841 million in Q2 to Q3. And, you know, when that happens, that's a shift from DDA to an interest-bearing within the firm. And so we'll see going from Q3 to Q4, we expect the decline to be near that amount, going Q3 to Q4, and then in Q1, we expect to see that rate of decline slow quite a bit. So when we look at, you know, kind of deeper into the portfolio and look at, you know, size cohorts, we can see the rate of change slowing, and that's what gives us some confidence that we'll see a slowdown here over the next six months.

Timur Braziler (VP)

Okay, and-

Marty Grunst (CFO)

Q4 will still be a higher number.

Timur Braziler (VP)

Okay. And I guess as you guys are thinking about funding the high single-digit loan growth next year, and pairing that with the comment for stable to maybe slightly growing deposits, how are you thinking about funding that growth? And I guess it appears that the spread you're getting on that loan growth relative to the funding sources is shrinking. And I'm just wondering, you know, obviously, you have the longer-term outlook, but why grow loans at such a fast pace when that spread is gonna be shrinking and there is broader economic uncertainty out there right now?

Marty Grunst (CFO)

Yeah. So if you look at the incremental loan growth, the spread on that incremental loan volume is actually widening. So we've been able to see a widening of spreads on new production, and the, the economics of that new production is strong. Not to mention the fact that that's coming with full relationships, so there's deposits, et cetera. But that, that incremental loan growth does have incrementally positive and wider spreads. So the funding question, it's gonna be a mix of, you know, some deposit growth, and there may be some smaller amount of wholesale funding in there as well, but either way, it doesn't matter which side of the, the whether it's funded with wholesale or deposits, that is incremental and profitable, to be sure.

Timur Braziler (VP)

Okay. Thanks for that color.

Operator (participant)

Thank you. This concludes today's question and answer session. I would like to turn the floor back over to Marty Grunst for closing comments.

Marty Grunst (CFO)

Thanks, everyone, again for joining us today. If you have further questions, please email us at [email protected]. Have a great day, everyone.

Operator (participant)

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.